This Downturn Will Stress-Test Roper's Differentiated Business Model

Summary

• Roper seems likely to see far less damage to its revenue and profit trajectory during this downturn, as a substantial amount of revenue/profit comes from subscription/recurring sources.
• There will be areas of weakness, particularly in Process and possibly including some medical and construction businesses, but Roper doesn't have much problematic end-market exposure.
• Explicitly modeling M&A increases modeling/valuation risk, but it's too significant to the business to ignore.
• Roper seems priced for a high single-digit long-term shareholder return; not the best return available, but likely with substantially less underlying business volatility.

I’d been getting more comfortable with Roper Technologies’ (NASDAQ:ROP) valuation recently, and the shares have held up extremely well so far this year, as the company’s strong recurrent revenue model is likely to see the company pass through this downturn with far less disruption than its industrial peer group. The question remains whether industrials are really a valid peer base anymore, but I don’t expect that to constrain the stock’s popularity.

My model assumes significant ongoing M&A, and there is now increased timing uncertainty on that, but I see little to disrupt the basic model. With an ongoing focus on niche-type businesses with barriers to entry, low maintenance capex needs, and low overall asset needs, I expect Roper to continue generating excellent free cash flow margins and free cash flow growth, even though the shares do otherwise look expensive on its organic growth numbers.

A Healthy Beat

With so much of Roper’s business leveraged to software and other recurring revenue streams, not to mention end-markets like health care and traffic management, there really isn’t a good peer group for comparisons anymore. While Roper did join its industrial “peers” with a healthy beat on first-quarter revenue (close to 5%), the organic growth of 4% was quite a bit better than the average industrial showing of around 4% contraction. Roper also did quite well on the segment operating level, beating expectations more than $0.10/share.

All of Roper’s segments produced organic growth this quarter, with Network Software & Systems (or NSS) up 9%, Application Software up 5%, Measurement & Analytical up 3%, and Process up 10%. Segment profits rose 3%, with a 60bp year-over-year margin decline. Measurement & Analytical and Process were the weaker performers, down 3% and 14%, respectively, while NS&S and Application Software grew 13% and 7%, respectively.

Roper once again

Analyst’s Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.